Companies’ Social Impact Increasingly Scrutinized by Investors.
Greg Wait of Falcons Rock gave his insight into the recent rise and benefits of socially responsible investing (SRI) for this BizTimes article from February 5th. Read February article.

History Has Steered Folks to Environmental, Social and Governance Investing.
In this Milwaukee Journal Sentinel article from July 15th, Tom Saler explores socially responsible investing (SRI) and breaks down some recent high-profile examples. Read July article.

New Firm Targets Socially Responsible Investors.
In this article from January 9th, Milwaukee Journal Sentinel reporter Kathleen Gallagher explores Greg Wait's launch of a new company that combines socially responsible investing and online investment advice. Read January article.

Investment Trends, with insights by Greg Wait. In the Milwaukee Journal Sentinel's October 17th article, Kathleen Gallagher and Greg Wait discuss the recent rise of environmental, social and governance, or ESG investing. Greg provides insight into how reduced risk and improved returns are causing money managers to include ESG investing in their portfolios. Read October article.

Responsible Investing: Creating Financial and Non-Financial Value by Greg Wait. Do investors sacrifice returns in pursuit of their goal of advocating for a better world in which to live?Learn more.

Ten-Year History of Investment Manager Performance by Greg Wait. As part of our process, we have conducted investment manager research and due diligence resulting in manager or fund recommendations to our clients. Here are our findings.

The month of September, 2013 marked the 10-year anniversary of Falcons Rock serving our clients and building relationships. We are grateful for all the years of friendship, loyalty, and support, and look forward to our next decade!

Investment Trends, with insights by Greg Wait. In the Milwaukee Journal Sentinel's July 20th article, Kathleen Gallagher and Greg Wait discuss the rising U.S. Treasury rates and using duration as a measure of risk. Greg's comments relate to whether we'll be "looking back on this short-term increase in yields as the warning shot for the much-anticipated longer-term rise in interest rates."Read July article.

Additional articles in the Milwaukee Journal Sentinel featuring Falcons Rock:
One is a fascinating story about a Mequon drug development company, which has a few of our clients as private investors. Read article about our angel investors

Another features us in the Market Trends column: Strategy targets uncertain economy - and how Falcons Rock confronts specter of slow growth.Read how we help clients get ready

There is a great deal of debate in the investment industry regarding active vs. passive (indexing) investment management. We researched this topic and the results might be surprising to you. Please see our research paper on this subject...more

We have experienced interesting situations with
our clients. To update you on our firm’s activities, check out examples
of recent work we have done for our clients...more

Bad Behavior

2016 Quarter 1 Market Review

Last week, the Three-Ring Circus, otherwise known as the Presidential political campaigns, rolled through Wisconsin. To me, it is disheartening that negative campaigning is the norm, and actually seems to work with the U.S. electorate. This year has been even worse than most, as “The Donald” is leaving candidates in his wake by spewing insults in every direction and others feel the need to follow suit. This behavior is a reminder that human beings are flawed, the squeaky wheel gets the media grease, and our society is heavily influenced by advertising and polarizing figures. I believe most of us are well-meaning and caring people, but we are subject to social pressures that can that lead to bad decisions.

There is a fascinating body of research relating to “behavioral finance” that seeks to understand why investors routinely make bad investment decisions. This field of study combines behavioral and cognitive psychology with conventional economics and finance to gain insight into the biases that cause some investors to behave irrationally and often against their best interests. The central theme of “the invisible hand” of traditional free-market economics is that people make rational decisions that are in their best interests. Behavioral finance may suggest otherwise. [By the way, the Milwaukee Repertory Theater recently produced The Invisible Hand, a thrilling new play that depicts Pakistani terrorists who kidnap an American investment banker and demand that he raise his ransom by trading in the financial markets…a real conversation-starter!]

There are several key concepts/biases uncovered by behavioral finance research1:

Anchoring – the tendency to attach or “anchor” our thoughts to a singular reference point or benchmark.

Mental Accounting – the tendency for people to separate their money into different accounts based on some subjective criteria.

Confirmation Bias – the tendency to selectively filter and pay more attention to information that supports a person’s preconceived opinion.

Hindsight Bias – a person believes (after the fact) that the onset of some past event was predictable and obvious, even though the event could not have been reasonably predicted.

Gambler’s Fallacy – the belief that the onset of a certain random event is less likely to occur following an event or series of events (think coin flips, or a basketball player on a hot shooting streak).

Herd Behavior – the tendency for individuals to mimic the actions (rational or irrational) of a larger group.

Overreaction and Availability Bias – the tendency to overreact to new information, or heavily weight decisions or opinions toward the most recent news.

Prospect Theory – people value gains and losses differently, and will base decisions on perceived gains rather than perceived losses…even when they achieve the same economic result.

It is easy to understand how these behavioral biases can lead to irrational investment decisions. So, what has the research shown regarding the returns generated by the average investor, who may be subject one of more of these tendencies?

Over the 20-year period ending 12/31/2014, here are the annualized returns of various asset classes and the average investor2:

U.S. stocks: 9.9%

U.S. bonds: 6.2%

Gold: 5.9%

Oil: 5.7%

Non-U.S. stocks: 5.4%

Average Investor: 2.5%

The “return gap” between the average investor and specific asset classes has lessened over the past 5-7 years, as the long run of the bull market in stocks is easier to navigate. Bear markets and the dramatic snapbacks that often follow are the worst environment for investors, due to behavioral biases.3

Over the trailing 10 years, the largest return gaps have been found in the riskiest mutual fund asset classes: regional stock funds (India, Asia/Pacific, Europe and Japan), high-volatility stock funds, and higher-cost funds.3

The smallest return gap was found in target retirement date funds, found mostly in 401(k) plans.3

Investors, as human beings, are challenged by our inherent weaknesses and biases. It is best to remain focused on a personal financial/investment plan, not the news. Owning less volatile investments, or a diversified portfolio containing a mix of asset classes and investment strategies, is the easiest plan to adhere to over time.

First Quarter 2016 Review

What a quarter it was in the financial markets! The term “roller-coaster” has never been more appropriate. With continued fear about a global recession, the stock market was firmly in negative “correction” territory…until February 11, when a rally began that brought equities all the way back to mostly positive returns by the end of the quarter.

The U.S. stock market finished the quarter with somewhat mixed returns depending on size, style and sector. Generally, large and mid-cap stocks registered gains, while growth-biased small cap stocks posted losses. The best performing sectors in the S&P 500 Index in Q1 included Telecom (+16.6%), Utilities (+15.6%), Consumer Staples (+5.6%) and Industrials (+5.0%). The worst performing sectors during the quarter were Health Care (-5.5%), Financials (-5.1%), and Consumer Discretionary (+1.6%).

In a turn of events, the U.S. Dollar weakened against most foreign currencies. Non-U.S. stocks, as represented by the MSCI ACWI Index, produced relatively flat returns for the quarter (+0.4% in U.S. Dollars, -1.4% in local currencies). In their local currencies, this quarter’s best performing countries included Brazil (+15.2%), Russia (+7.9%), and the U.K. (+0.2%). Selected countries whose stock markets delivered the worst returns included Japan
(-12.5%), Germany (-7.0%) and China (-4.7%).

The bond markets generated positive returns, as investors’ fears early in the quarter resulted in flows to U.S. Treasuries and Municipals, and optimism in the latter weeks of the quarter boosted corporate bonds. Cash (money market funds) continue to earn next-to-nothing as the Fed Funds Rate remains accommodative.

Most balanced portfolios experienced small gains during the quarter, but early indications are that many alternative strategies appear to have disappointed.

Here are the returns for select market indices for Q1 2016 (as stated in U.S. dollars):

Responsible Investing Corner

Iroquois Valley Farms, LLC (IVF) is an example of an impact investment that hopes to generate a “triple bottom line” of above-market long-term returns, environmental sustainability, and the social benefits of healthy food production. Iroquois Valley Farms invests in farm land and leases the land to farmers who commit to converting it to organic farmland and growing organic produce. It has developed the Young Farmers Land Access Program with generational tenured leases, and the majority of leases are to millennial farmers. Typically, it takes three years of soil being chemical-free before it can be certified as organic and up to ten years before the soil is fully functioning organically. Conventional farming relies on crop subsidies, cheap oil, and draining aquifers without restraint…when those conditions change, sustainable operations will be positioned to grow where conventional methods may fail. For patient investors, sustainable farming is resilient and may be a big winner in the long run. Some estimate that sustainable farming methods have already increased revenues per acre by 54 percent per year. So far, since the inception of Iroquois Valley Farms in 2007, initial investors have achieved a valuation at 2.5x money.

Iroquois Valley Farms is a certified B Corporation, which is a corporate structure that obligates businesses to be accountable for creating positive social and environmental impact. IVF was the first private company to connect farmers and investors with organic farmland. Their impact statement is taken from the Great Law of Peace of the Iroquois Nation, “In every deliberation one must consider the impact on the seventh generation.” IVF believes that their environmental impact includes: certified organic fields and production, soil restoration, carbon sequestration, pasture and perennial grasses, renewable energy projects, pollinator and wildlife habitats, and agroforestry practices.

If you would like to learn more about Iroquois Valley Farms, please let me know.

This and That

In March, roughly 65% of government bonds worldwide were yielding less than 1%, while the proportion of bonds yielding negative rates had grown to 30%.4 That’s right…an investor who purchases a bond from the Bank of Japan or the European Central Bank are guaranteed to lose money if they hold it to maturity! These governments are trying to stimulate growth by encouraging banks to lend more aggressively, corporations to borrow and invest, and consumers to borrow and spend.

The U.S. job market is booming as the ADP National Employment report showed private-sector employment rose 200,000 between February and March, double that needed to keep up with growth in the working age population. However, first quarter GDP growth estimates appear to be less than 1%, highlighting the glaring but not rare disconnect between GDP and employment growth.5

The current economic expansion has reached 81 months, which makes this the fourth longest expansion since 1900…pretty impressive! The average expansion following an economic recession lasts 46 months.6

Municipal bond yields are higher than US Treasury bond yields, with a Muni/Treasury yield ratio of 1.047…this is great for taxable investors!

One investment firm notes that corporate managements are increasingly inward-focused, primarily on how to garner market share and maintain profitability. This is seen as a change from the past several years when they were more centered on growing with the overall economy and increasing profit margins.8

“Very few investors seem to be aware of the fact that while common stock prices are very volatile, earnings and dividends are not. Businesses are nowhere near as volatile as the stock market. Earnings and dividends determine stock values in the long run, but those old nemeses fear and greed usually dominate in the short term.” – Bob Kirby, Capital Group

With all of the political uncertainty and global economic concerns, the markets are likely to remain volatile throughout the coming year. It appears that oil prices are stabilizing as is the US Dollar, both of which should be comforting to the markets. European GDP growth is pushing forward slowly but steadily, their unemployment rate is decreasing and credit is increasing. Japan is basically out of workers and showing extremely slow growth. The Chinese government is seeking to maintain financial stability and promote growth in the short term. All that said, the relationship between world economies and global stock markets is tenuous, at best. Therefore, we all need to do our best to avoid the behavioral biases that tend to cause bad investment decisions. We are here to help our clients stick with their plan!

We are privileged to serve each of you. Thank you for the trust you’ve placed with Falcons Rock.